Daily Telegraph Article  By Simon Benson and Rhys Haynes May 09, 2008

THE Lane Cove Tunnel could be broke by next year in a second spectacular billion-dollar toll road failure for the State Government in 18 months.

Despite the Government trying to force motorists into the tunnel by closing a lane of Epping Rd for buses, volume has dropped to half that forecast.

The continued drop in motorists using the tunnel yesterday prompted ratings agencies to issue it with an unprecedented "two notch" financial downgrade, warning that the $1.1 billion investment was at risk.

Investor ratings agency Moody's warned that the tunnel would run out of cash by the end of 2009 unless traffic volumes increased, echoing a statement by Standard & Poor's last week.

Late yesterday, tunnel operators Connector Motorways admitted it was trying to refinance the bungled project.

Moody's made the highly unusual decision to downgrade the Lane Cove Tunnel Finance Company two notches from Ba3 to Ba1 "after continued disappointing levels of traffic over the last few months".

The ratings agencies are normally conservative with their advice and rarely move more than one notch at a time.

"The downgrade follows continued lower traffic volumes for March and April," it said.

"Traffic was expected to ramp up after the bus lanes on Epping Rd (the surface alternative to the tunnel) became operational on March 10, but this outcome has not materialised. Traffic volumes indicated by Monthly Average Daily Traffic (MADT) were maintained at 59,000 vehicles each for March and April after 62,000 in February."

It claimed that the company had sufficient cash flows to service its debt until the end of 2009, but said: "Moody's does not currently believe that traffic volumes will increase to sufficient levels to service debt in the long term."

The initial forecasts suggested 100,000 cars would be using the tunnel by September this year.

The Hong Kong company CKI, which part financed the Cross City Tunnel, has already written off its remaining $113 million holdings in the Lane Cove Tunnel.

The tunnel is now looking like following the fate of the Cross City Tunnel, which was put into receivership in December 2006 following a failure to generate the expected traffic flows.

Meanwhile, public transport patronage has increased by 4 per cent.

CEO of Connector Motorways Ian Hunt said: "This downgrade does not in any way affect motorists using the Lane Cove Tunnel and Falcon St Gateway, or the day-to-day operation of Connector Motorways.

"The project debt is still rated AAA (top investment grade) due to the AAA rating of the project's financial guarantor.

"While patronage is below our 18-24 month ramp-up projections, we remain cautiously optimistic that growth will continue.

"Lane Cove Tunnel and Falcon St Gateway have reduced travel times and delivered motorists significant benefits."

Opposition Leader Barry O'Farrell said it was further evidence of the Government's inability to do deals with the private sector, adding: "Whether the Lane Cove Tunnel, Cross City Tunnel, TCard or even Bathurst Hospital, this Government never delivers for taxpayers."

Roads Minister Eric Roozendaal said: "Travel times for buses are around three times faster than the same trip before the tunnel was built."

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While Bank critics welcome increased flexibility in infrastructure investment, there are fears that a planned expansion of the commercialised model may undermine poverty reduction efforts.

The Bank estimates that, in order to reach the Millennium Development Goals, developing countries will have to double their spending on infrastructure. In 2005, the Bank is increasing its lending for infrastructure to $7 billion, an increase of $1 billion over the previous year. However, expanding lending in the form of subsidies for private providers may result in a re-run of the problems of corruption, inefficiency and low access witnessed over the past decades.

A June report from the World Bank says that the privatisation of infrastructure has been "oversold and misunderstood". The report's author, Ioannis Kessides, an economist in the development research group, concedes that "privatisation was heralded as an elixir that would rejuvenate lethargic, wasteful infrastructure industries and revitalize stagnating economies." The failure to do so has led to widespread "skepticism and outright hostility toward privatisation."

However, despite the "significant risks" posed by infrastructure privatisation if not accompanied by appropriate structural and regulatory safeguards, the report concludes that it "offers benefits too big to ignore for governments, operators, and consumers." The success of privatisation efforts, says Kessides, varies greatly by sector: telecommunications offers the most compelling case for privatisation, while transport networks, electricity and water supply are "more problematic".

In a paper for the Citizens' Network on Essential Services, Tim Kessler argues that in such "problematic" sectors, "guarantees and subsidies that help to ensure corporate profitability can pose serious risks and costs for taxpayers." In the face of rapidly declining private sector interest in infrastructure since 1997, the Bank has focused on promoting a range of instruments to attract private sector participation.

Some fiscal supports for private infrastructure, such as construction subsidies and tax holidays, have been around for a long time. More recently, the World Bank has pioneered 'output-based aid' where the Bank agrees with the government to pay private providers for services actually delivered. Kessler argues that "figuring out whether a subcontractor is doing its job well and for the right price is costly and requires technically qualified staff." The same regulatory capacity, which "far exceeds" that available in most developing country governments, is needed if subsidies are used to ensure access for low-income citizens. Governments must make long-term estimates of the subsidies required; this demands a degree of fiscal continuity which many developing countries subject to IMF fiscal austerity measures may be unable to meet (see box below).

IMF accounting: the genie in the ledger

The Fund is under pressure both from borrowing countries and lenders to relax its fixation with fiscal responsibility to allow for greater infrastructure investment. Pressures to run budget surpluses under Fund-supported programmes have contributed to insufficient spending on infrastructure. However, to address this gap, the Fund is open to charges from within and from outside that it risks governments de-prioritising social spending, crowding out private investment and racking up unsustainable debts.

A further complication arises over how the 'fiscal balance' is to be defined. The Fund has decided that it should cover the whole of the public sector excluding commercially-run public enterprises. However, this has raised concerns amongst civil society observers that only investment in publicly-run infrastructure will be restricted by fiscal austerity measures, creating a bias towards private provision. In response to these critiques and to pressure from the Brazilian government (see Comment, Update 40), the Fund is to allow the Brazilian government to similarly exclude investments by publicly-run enterprises from the calculation of government budget targets on a pilot basis.

The Fund is also considering how to better reflect the fiscal risks of public-private partnerships (PPPs) in government accounts. There is support for disclosing the potential future costs to government from such arrangements. This would respond to a long-standing civil society critique that PPPs are simply a way to bypass spending controls, while the government still bears most of the risk. In the absence of internationally agreed guidance on how to do this, the Fund has decided that "the known and potential future cost of PPPs should be disclosed, and taken into account when undertaking debt sustainability analysis."

Kessler argues that even more worrying than output-based aid are those corporate subsidies which create liabilities "whose financial impact and timing governments cannot predict". This includes purchase agreements, where governments agree to buy the output of a private provider, usually in hard currency, regardless of changes in demand or fluctuations in the exchange rate. Recessions, devaluations and unfavourable contractual terms have brought several utilities to the brink of financial collapse. Similar risks are posed by guarantees which lock-in price levels.

Kessler concludes that the Bank's eagerness to promote private provision arrangements stems from the belief that the public sector cannot be reformed. Ironically, public service providers often become more efficient as a precondition of privatisation.

Government officials in the Philippines, responding to World Bank and ADB pressure to privatize the National Power Corporation, plan an 80% increase in electricity rates. The increase is aimed at making the power industry attractive to investors who have been hesitant to enter. Activists are planning mass mobilisations if the government goes ahead. Freedom from Debt Coalition says that Philippine electricity rates are already the fourth highest in the world.

Related articles

Lula and Kirchner want IMF to relax its grip Comment|Roberto Bissio|24 May 2004|update 40|url

A new initiative to rewrite the rules of engagement with the IMF could mark the biggest change in creditor-debtor relations in a generation. read article...

World Bank announces renewed big infrastructure push News|Bretton Woods Project|8 September 2003|update 36|url

The World Bank President has pledged that the Bank will revive its support for megaprojects and a new report expresses serious concerns about the Bank's track record in this area. read article...

Middle-income strategy threatens safeguards News|Bretton Woods Project|28 May 2004|update 40|url

A coalition of NGOs led by International Rivers Network has raised alarm bells that a proposed World Bank middle income country strategy will seriously weaken policies meant to protect vulnerable groups and the environment. read article...

The World Bank’s high-risk hypocrisy Comment|Peter Bosshard|5 April 2004|update 39|url

the World Bank is not serious about the social and environmental policies it trumpets at global conferences. Senior World Bank staff in its India office indicated that they neither know nor care about procedures that are supposed to make its infrastructure lending socially responsible. This represents institutional hypocrisy. read article...

Related resources

Reforming Infrastructure: Privatization, Regulation, and Competition Briefing|World Bank|26 July 2004|Web page|URL

Who’s taking risks? How the World Bank pushes private infrastructure by Tim Kessler Briefing|Citizens' Network for Essential Services|26 July 2004|PDF|URL

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The Capacity of States to Oversee Privatization Deals

Report from PIRG

Investors and operators of private toll roads in the United States have focused most of their attention on state governments. . Road privatization deals give responsibility to companies to maintain and invest in roads, while typically granting the private companies the right to collect increasing tolls for themselves for fifty or more years or more. In order to protect the public, states must have the capacity to evaluate contracts up-front. And if a deal is signed, the state must also have the capacity to independently monitor and enforce compliance l. Adequate capacity to oversee these deals is particularly important because the companies themselves have a financial incentive to invest less in the roadways, to raise tolls as high as possible, and to sue the state whenever its actions diminish toll revenue.

In order to protect the public, governments must take a number of steps. Analysis by the federal General Accountability Office shows that states must develop systematic approaches to identifying and evaluating the public interest as governments have done in many other countries.

These protections are especially important when projects do not use federal funds, and therefore would otherwise typically lack the standard transparency rules and public interest considerations that major transportation project would otherwise meet.

States have not developed systematic approaches to identifying and evaluating the public interest Before signing a private road contract, up-front public interest analysis tools are important to evaluate the expected costs and benefits of a private operator, as well as the most appropriate means to deliver the project. The failure to use such tools can lead to certain aspects of the public interest being overlooked, such as environmental standards and equity concerns.

Governments in other countries, such as Australia and the United Kingdom, have developed systematic approaches to identifying and evaluating the public interest before entering into privatization agreements. Typically, these governments identify important elements of the public interest and develop criteria for how they should be considered. In Australia, for example, the state of Victoria requires all privatization agreements to be judged according to eight specific public interests tests, including whether the rights and views of affected communities have been heard and protected, whether community health and safety is ensured, and that there are sufficient safeguards to ensure public access to the infrastructure.

These public interest evaluations are conducted often during the negotiations to adequately protect the public. Unfortunately, these kinds of safeguards have been used much less in the United States. In a recent report titled, Highway Public-Private Partnerships: More Rigorous Up-front Analysis Could Better Secure Potential Benefits and Protect the Public Interest, the U.S. Governmental Accountability Office notes that neither Chicago nor Indiana employed public interest tests prior to the leasing of the Chicago Skyway or the Indiana Toll Road, such as ensuring transparency of negotiations and examining effects on regional mobility. They also failed to use comparisons with the public sector to examine the long-term costs of a project and the value of transferring risk to the private sector. In fact, Governor Daniels did not even commission an independent financial analysis of the concession until the deal was almost complete.

Similarly, transportation officials in other states, such as New Jersey, Pennsylvania, and Illinois, admit that they have not developed a systematic approach to assessing public interest concerns. The failure to use formal public interest tests may result in certain aspects of the public interest being overlooked, such as the value of foregone toll revenue. When states have decided midcourse to conduct thorough analysis, it has often changed their decisions. In Texas, for example, Harris County conducted a study in 2006 to examine the value of a long-term concession compared to retaining public control. The County determined that they would gain little through the concession, and that by implementing more aggressive tolling they could realize similar or greater financial gains. Thus, Harris County opted to retain control of the toll roads.

Similarly, when Oregon hired a consultant to compare the estimated costs of private versus public sector financing, they concluded that the cost of the privately financed project was not justified given the limited value of risk transfer. Unfortunately, the study was not conducted until after the private partners had already done substantial early development work.

Additionally, many states lack legislation requiring transparency in private road projects, such as making proposals available to affected communities. These rules may be justified on the basis that private road builder and operators regard their own analysis and proposals as “proprietary” business secrets. But such rules prevent full public review of the process and undermine both transparency and the opportunity for full public participation.

Lack of federal involvement considerably reduces consideration of public interests

While the federal government in recent years has aggressively promoted road privatization through new laws, it has done little to develop or disseminate public interest protections for such deals. This has particularly profound consequences when private funding replaces federal grants that require public interest safeguards and reviews.

The Bush Administration and the U.S. Department of Transportation have actively promoted privatization agreements through various policies and practices, including programs that waive certain federal regulations or grant tax-free bond subsidies. For example, the federal government has waived regulations for projects in Texas and Oregon that prevent private investors from being involved in a highway project until the federally mandated environmental review process has been completed. USDOT and the Federal Highway Administration have also developed publications that promote privatization agreements to state officials through activities such as drafting model legislation and creating an promotional websites and newsletter.

Despite these efforts at promotion, the federal government has not been directly involved in regulating privatization agreements, even when national interests may be affected. When federal funds are used in highway construction, the projects are constrained by numerous federal regulations. These regulations relate to issues such as prevailing wages (Davis-Bacon), assistance for small and minority-owned businesses (disadvantaged business enterprises), environmental review (NEPA), air quality improvement (clean air conformity), environmental mitigation (wetlands), resource conservation (4(f) endangered species), domestic job and industrial base protection (Buy America), and accommodation for the disabled (ADA).

Transportation plans must also be developed in a transparent manner and reflect the collective views of the community. However, when federal funds are not used, no federal guideline exists to regulate the projects. States can even avoid federal protections for the public by segmenting their projects and funding selected portions that would not pass federal muster with private financing.

Even when federal funds are used, the federal government has exhibited an inability or unwillingness to become actively involved in the projects. The Federal Highway Administration has yet to develop a federal definition of the “public interest”, and officials have not provided any guidance on identifying and evaluating the public interest.

This creates the potential for national public interest concerns, such as interstate commerce issues, to be ignored. For example, federal officials did not review the terms of the concession agreement for the Indiana Toll Road, even though 60 percent of the traffic is interstate in nature. Such review was not required, according to federal officials, because the $1.9 million in earlier federal funds had been repaid.

Similarly, because the lease of the Chicago Skyway did not include any new expenditure of federal funds, there was no requirement that the Federal Highway Administration approve the lease. The law did require the FHWA to ensure that the toll rates under the agreement represented a reasonable rate of return. However, because federal officials had no standard definition of a ‘reasonable rate of return’, they deferred to the state’s discretion.

Furthermore, though the federal government has the authority to oversee any project receiving federal aid, it does so only rarely. Following the passage of the Intermodal Surface Transportation Equity Act in 1991, the federal government has increasingly delegated oversight responsibility to state Departments of Transportations.

Unfortunately, many states lack the ability to properly oversee projects. Lack of a comprehensive planning process also means that the choice of which roads get built can be determined by profitability instead of overall effect on the road network. As any driver knows, changes on one roadway seriously affect traffic flow on other connected roads.

Transportation planners therefore evaluate potential road projects on a wide range of criterion, including effects that extend beyond the roads themselves. New roads can create traffic bottlenecks or can create new problems with concentrated air pollution, for instance. New roads create new land-use patterns that may require costly future public infrastructure investments. The planning process makes sure that such interrelated effects are considered and ensure that alternatives are evaluated according to what fits best into long-term regional plans. Limiting the process to bidding and profitability over a single road leaves much unconsidered.

Some states have enacted, and others are considering, laws that will permit the submission of unsolicited proposals by private firms for transportation projects. These laws would require public transportation agencies to review the proposals within specified timeframes, and to go forward if the proposed projects are determined feasible – even if the roadway is not a priority or conflicts with other plans.

In the Texas SH 130 project, this reversal of traditional planning has gone so far that the private encourage toll traffic, such as lowering the speed limit on competing roadways.

Ultimately, a lack of federal involvement in transportation projects can be detrimental to interstate transportation concerns. States may agree to long-term concessions that include noncompete or concession clauses which may hamper the nation’s ability to properly respond to new transportation needs. Additionally, many of the transportation projects being considered include facilities in more than one state, or projects that are located in one area but benefit larger regions.

If these states act in complete independence of each other, without federal oversight, they are likely to produce an uncoordinated and inefficient state transportation system. Thus it is essential for the federal government to take a more active role in privatization agreements to ensure that national public interests are not supplanted by short-term considerations of state governments.

Lack of capacity forces states to rely on private companies and their partners for oversight, creating serious conflicts of interest

Private contractors have a monetary incentive to under-invest in projects and to finish them quickly. For this reason, public oversight of transportation projects is essential to ensure that safety standards are maintained. Paradoxically though, while the budgets for transportation departments have increased over the past five years, staffing levels have either declined or remained stagnant.

This has resulted in an unprecedented level of ‘contracting-out’ by state agencies, leading to a decline in oversight.

Long-term concession deals are extremely complex, and state DOTS are unlikely to have the inhouse expertise needed to plan, conduct and execute privatization agreements. In 2006, the Federal Highway Administration found that several state projects had been delayed due to inadequate staff capacity and expertise.

In Georgia, the DOT’s new commissioner even decided to end all privatization agreements due to her staff’s lack of experience. In order to manage these projects, state DOTs are increasingly outsourcing various aspects of their projects to private contractors and consultants, including engineering and inspections. Unfortunately, this outsourcing further erodes in-house expertise, which will further diminish the ability to oversee projects in the future.

Private toll road concessions are a more extreme form of out-sourcing, and historical trends indicate that state DOTs will be unable to adequately monitor these projects. The supervision and performance assessment functions performed by the departments are often understaffed and under-budgeted. Even though concession agreements may require the private entity to maintain a certain level of investment in the road, if the state does not properly monitor these agreements then the investments are likely to be substandard. In fact, a series of Federal Highway Administration reviews of quality assurance activities found numerous deficiencies in state oversight of consultants, “such as a lack of independent sampling of highway materials for verifications tests; inadequate statistical comparisons of the tests results; and insufficient state control of test samples, sampling locations, and testing data.” The FHWA further found that pavement on highways is deteriorating faster than expected, which they attribute in part to the weaknesses in oversight.

Furthermore, a reliance on outside contractors increases the potential for conflicts of interest that may be detrimental to the public. With the growing interest in privatization agreements among investment banking firms, there is a possibility that a firm may provide financial advice to a state while simultaneously engaging in investment banking for the same deal.

For example, Goldman Sachs was an advisor to Indiana on the concession of its toll road, but failed to mention that it was also creating a fund whose sole purpose was to invest in infrastructure. In fact, while it was supposedly advising Indiana on how to get the best return, its Australian subsidiary’s mutual funds were investing in MIG (the concessionaire), becoming de facto investors in the deal. These potential conflicts of interest, coupled with the lack of oversight by state officials, will likely result in states receiving an unfair deal.

Even if a conflict of interest does not exist, private advisors may still fail to adequately represent the interests of the state. They may, for example, not wish to alienate private-sector firms that may want to use them in a future deal.

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The Indiana House of Representatives' Democratic Caucus issued the following statement:

The following is the text of a guest column authored by Indiana House Democrat Leader B. Patrick Bauer (D-South Bend):

"Indiana's experience with privatization has focused almost entirely on rumored benefits, without any consideration of the pitfalls.

"We are told the sale of the Indiana Toll Road to foreign investors will help us address infrastructure improvements over the next decade. For a one-time infusion of cash, we will be giving up possession of a state asset for 75 years. Any money generated from the operation of this road will be sent overseas until 2081 (over $100 billion), long after we have used up sale proceeds ($3 to $4 billion). The foreign consortium has told investors that it expects to operate the road at a 13-percent profit.

"Many of us felt a better idea would be to use toll road profits to pay for our infrastructure needs, a move which would generate as much money as a sale and enable us to keep possession of the road. Our concerns were ignored. Advocates now are contemplating turning an interstate extension in southern Indiana into a privately-owned toll road.

"Additionally, control over most of our state's family and social services network is likely to fall into the hands of private firms that have been roundly criticized and investigated elsewhere for failure to live up to promised service. States have re-assumed control of these services.

"There is concern about the role privatization plays in operating programs that benefit a state's general population. A private company's primary motivation is to earn a profit. If profits are not being earned, a company reduces costs by cutting personnel and services.

"More states are rejecting the concept of privatization. In Texas, one county already has chosen not to turn a road over to a private company, preferring to operate the road themselves and keep the profits.

"All of us want to see government operate in a fiscally sound, accountable manner. If the results are that people are not going to get the services they need, that is not good. Governments should not be in the business of enriching private companies at the expense of those they serve." Contact: John Schorg, 317/232-9621, 1/800-382-9842, jschorg@iga.state.in.us.

John Schorg, 317/232-9621, 1/800-382-9842, jschorg@iga.state.in.us.

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                Still just a Texas problem?

While oil companies are posting record profits, the White House plans to dig further into people's pockets.

By Christopher Conkey   Wall Street Journal  Aug. 11, 2008

WASHINGTON -- The Bush administration unveiled a plan to impose new tolls on freeways and encourage more private investment to finance road and mass-transit projects, a move aimed at stirring debate as lawmakers prepare for a major overhaul of transportation policy.

The White House says more tolls and public-private partnerships can solve perhaps the biggest problem confronting the nation's aging infrastructure: There are limited funds available to upgrade transportation networks and too many federal funds are doled out inefficiently through earmarks and pet projects that do little to improve mobility or reduce congestion.

The search for alternative funding sources is ramping up because Americans are driving less and shifting to more fuel-efficient vehicles. That means they will be paying less in gasoline and diesel-fuel taxes, which traditionally have been the biggest source of federal funding for highway and mass-transit construction.

Many states are moving to increase existing tolls. Pennsylvania, for example, is hoping to win federal permission for new tolls on a standing interstate. Meanwhile, several states are turning to business consortiums to finance, build and operate new highways, bridges and tunnels, although a political backlash has slowed the push in recent years.

The administration's proposal comes as Congress gears up to start work later this year on a six-year transportation spending bill that could cost well more than $400 billion. The last multiyear bill, which expires in September 2009, carried a $286 billion tab.

Earlier this year, a bipartisan commission concluded the nation is spending only about 40% of what is needed to reduce congestion, improve safety and spur economic growth. Transportation Secretary Mary Peters served on the commission but dissented from the majority view that gas taxes should more than double in coming years to support a big increase in transportation spending.

Ms. Peters says gas-tax rates should hold steady -- at 18.4 cents a gallon for regular gasoline and 24.4 cents a gallon for diesel, where they have stood for more than a decade -- and private money and toll revenue can address any needed increases in funding. She declined Tuesday to say how much more the U.S. needs to increase its overall spending on transportation infrastructure. Instead, she suggested ways to make transportation spending less wasteful.

"Our federal approach to transportation is broken," she said. "And no amount of tweaking, adjusting or adding new layers on top will make things better."

Many Democrats objected to the administration's plan, saying it could have gone further in identifying ways to raise investment and spur projects that could unclog major choke points. Perhaps the most common complaint centered on the shift in reliance from gas taxes to private-sector dollars.

"It's basically an opportunity for people who have wanted to systematically reduce the federal participation in infrastructure," said Rep. Earl Blumenauer (D., Ore.), who is spearheading a transportation debate in the House. "It's going to fall with a thud."

The two major presidential candidates haven't released detailed plans on transportation funding, even as the issue is sure to be one of next year's biggest legislative battles. Republican Sen. John McCain has stressed the need to eliminate earmarks and pet projects. Democratic Sen. Barack Obama supports the creation of a $60 billion national infrastructure bank that would fund projects of regional and national significance. The two have also sparred over Mr. McCain's proposal to give consumers a gas-tax holiday this summer.

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Selling off assets a mistake

By Michael A. Olivas   Houston Chronicle  Nov. 13, 2007

The financial wizards of Wall Street are dancing themselves into a frenzy after discovering a golden opportunity right beneath their noses.

Like astronomers excited by a new celestial body, large investment houses are now sweeping the landscape with telescopes, hunting for attractive public assets that can be "privatized" through purchase or lease. From toll roads in Indiana to lotteries in Texas and more than a dozen states, all of our revenue-generating public assets are up for grabs.

Unless we stop the madness, we risk giving away key components of our public infrastructure at fire-sale prices.

Why should we care about who owns our highways, operates our lotteries or manages our public networks? That's the sly question posed to us by investment houses proffering bales of greenbacks to cash-strapped states throughout the country.

Perhaps the best reason to be wary of these megadeals is the scale of the fervor they have generated on Wall Street. If we've learned anything from the investor scandals of the past two decades, it's this: If a deal sounds too good to be true, it probably is.

Unless we stop the headlong privatization of public investments, we may wake up one day repeating Gertrude Stein's famous line: "There is no there there." But unlike Stein, we won't be talking only about Oakland — we'll be lamenting the barren balance sheets of our public treasuries.

Here are five reasons I believe we should rethink our stance toward privatization:

• Reason No. 1: Private interests are not driven to serve public needs.
There are two simple reasons why Wall Street wants to buy or lease state assets: They already exist, and they generate tons of cash. But in addition to paying down debt (in the case of a toll road, for example), these assets fund important public initiatives involving transportation, health, education and other essential government services. In Texas, to cite just one example, more than $1 billion collected through the Texas Lottery finances statewide education initiatives and medical research at the University of Texas Medical Branch at Galveston.

Arrangements such as these were carefully negotiated in the public arena, and it's doubtful if any of them could survive privatization. The private world lives by a simple credo: If it fails to deliver profit, it deserves to be eliminated. So, unless we resist the impulse to privatize, there's bad news ahead for Texas schoolchildren and researchers at UTMB-Galveston and for other worthy citizens and public needs nationwide.

And just where do we draw the line? Are state pension funds up for grabs, along with all of our state highway departments?

• Private companies are not guardians of public trust.
It's worth remembering how the Houston Astros opened their 2000 season in a spiffy new stadium named "Enron Field." The lesson is that companies come and go, and there are no guarantees that the purchasers or lessees of our public assets will perform any better than the likes of Enron, WorldCom or Tyco.

When our publicly elected officials perform badly, or criminally, voters at least have the opportunity to vote the bad guys out of office. But when we relinquish the control of our state assets to "outside entities," we are literally at their mercy.

• Beware public officials who resurface in private sectors.
During his 24-year tenure as a U.S. congressman and senator, Phil Gramm presided over numerous public initiatives in Texas. After leaving office, he resurfaced as one of the powerbrokers at UBS, the international brokerage house. Similarly, Kathleen Brown served as treasurer of California. She now works for Goldman Sachs and is spearheading an effort to lease the California lottery.

Ex-politicos are certainly entitled to earn a living, but there's something unsettling about powerful politicians moving into new roles where they can target public assets for lease or purchase. The easiest way to ensure a smooth transition from public to private life for these former politicians is to cut them off at the pass — and prevent the sale or lease of public assets that were created or operated during their tenures in office.

• States will never recoup their public investments.
By leasing its key tollroad to a foreign investment group, Indiana earned an instant windfall of nearly $4 billion. Despite the huge up-front payment, critics of the deal say that Indiana will never recoup the massive public investments that created and sustained the tollroad over the years. Private companies that pick the low-hanging fruit of public assets sustain zero start-up costs, are unburdened by government employees and their pensions and avoid the risks that taxpayers assumed when they voted to fund the project. This state of affairs has a name — "privateering" — and it's not in the public interest, since we are long past the point of provoking land rushes to "tame the frontier."

The ongoing benefits of our public assets belong to the taxpayers who created them — and not to international banks, U.S. private interests or former governmental officials cashing in on their connections.

• Beware a future that blurs public and private interests.
Building and maintaining a large public highway can involve eminent domain and financing supplied through tax-free bonds. These techniques are the preserve of politicians acting in the public interest, and they have no application in the private arena. After an investment house acquires a toll road, it's easy to imagine the board of directors voting to add new lanes — but only to serve drivers traveling to and from communities being developed by the firm and its investors. And if land needs to be condemned to create these new corridors, who gets to wield the power of eminent domain — an elected official, or the CEO of a major investment group?

Using information obtained under the Freedom of Information Act, The New York Times confirmed how companies are pursuing a concerted campaign to buy and lease large public assets, and are training their ranks to counter any voices of skepticism. But before we sell or lease the fruits of our public treasuries, a little skepticism may be a good thing.

Let's put the burden of persuasion and proof on those who would open their books, enter into full disclosure of public-private arrangements and fees and convince us that we should give them the keys to the public store.

I'll be thinking about these and other points the next time I attend a game at Enron Field, err, umm, make that Minute Maid Park.

Olivas is William B. Bates Distinguished Chair of Law at the University of Houston Law Center.

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Lowering speed limit to promote toll road?

By Patrick Driscoll   San Antonio Express-News   Nov. 6, 2007

A recent toll road contract that shoehorns market incentives into a government monopoly would reward the state for lowering speed limits on Interstate 35, effectively steering drivers to the toll road.

The privatization contract for Texas 130 from Austin to Seguin, cutting a parallel path east of I-35, was quietly signed in March amid a legislative furor over whether to freeze such agreements. It includes a controversial clause that penalizes the state for widening or building competing roads.

If a project over the next 50 years — with some exceptions — interferes with Texas 130 toll traffic, the Texas Department of Transportation would have to pay Cintra of Spain and Zachry Construction Corp. of San Antonio for their lost profits.

But the state can also get credit, though not payment, for driving traffic to the tollway, including by lowering posted speeds on I-35.

Not that TxDOT would do that, and certainly not for financial gain, spokeswoman Gaby Garcia said.

"We don't expect to be reducing speed limits on I-35," she said. "They are set by traffic engineering studies and not by economic gain."

But toll critics say a gate is open to the manipulation of I-35 traffic to ensure toll profits, and they don't trust TxDOT as the sentry.

"Our highways are being hijacked for private interests," said Terri Hall of Texans United for Reform and Freedom. "Who's going to rein in this agency? It just baffles me."

To change a speed limit on a road, TxDOT usually follows a complex formula based on the fastest pace set by 85 percent of motorists. But conditions such as crash rates could warrant lower speeds.

Laws and policies can also lower speeds, for reasons such as conserving gas.

"Speed limits are not arbitrarily set," Garcia said.

But just as a speed limit giveth, sometimes it taketh away.

If TxDOT raises the speed limit on I-35, it must pay Cintra-Zachry for any toll losses, according to a maze of requirements in the 192-page toll contract and its 476 pages of support documents.

Oddly, any improvements to the freeway are exempt from the competition clause. Also exempt are projects in existing 25-year plans.

The contract doesn't stop there — it also covers speed limits for the 40 miles of Texas 130 that will run from Seguin to south of Austin, where it'll hook up with another segment that now loops around the city.

Cintra-Zachry will pay TxDOT $25 million upfront if the limit is set at 70 mph but will fatten the offer to $92 million for 80 mph and $125 million for 85 mph, which state law allows. The agency could opt instead to take a growing bite of profits.

Under the privatization deal, TxDOT's first, Cintra-Zachry will finance, build and operate the $1.3 billion tollway in the hope of eventually turning a profit.

Motorists in cars will pay about 15 cents a mile, with rate increases capped to the annual growth of state domestic product. There will be no tollbooths — collections will be done with electronic tags and cameras.

Cintra-Zachry recently began a process to buy the land, and it expects to start construction in a year or two and open the roadway in 2012. The state will handle property disputes.

************

                 
               Should We Privatize Airports?

By Evan Sparks  American Enterprise Institute December 5, 2008

Competition, choice, and proper incentives would create a safe and efficient aviation infrastructure sector.

In 1977, as a group of policymakers attempted to apply economic theory to the regulation of airlines, future American Airlines (AA) chairman Robert Crandall was not happy. Then an executive at AA, Crandall claimed that the economists’ ideas would ruin the airline industry. Things came to a head when he confronted a Senate lawyer prior to a hearing, reportedly shouting: “You f—king academic eggheads! You don’t know s—t. You can’t deregulate this industry. You’re going to wreck it. You don’t know a g——n thing!”

Thirty years after a bipartisan coalition passed the Airline Deregulation Act (in October 1978), the subject is still hotly debated. Supporters of deregulation claim that it worked mostly as predicted: fares fell dramatically in real terms as new entrants clamored to serve competitive markets. Critics such as Crandall point to numerous bankruptcies, industry upheaval, and the increasingly miserable experience of air travel as evidence of its failings.

As I noted in the September/October issue of THE AMERICAN, proponents of the Airline Deregulation Act knew at the time that it was incomplete. Congress deregulated the airline sector but left the government-run aviation infrastructure intact. As deregulation guru Alfred E. Kahn said in 1978, “There is no guarantee that freer competition on the airline side of the equation—that is the part that creates the demand for airports—alone will solve these problems. On the contrary, it will stimulate more air travel.” Competition unleashed a torrent of demand for flying, but the infrastructure has not been able to keep up. Airports are still largely owned and operated by the government. They serve as chokepoints in the aviation system, and their capacity has been constrained by the Federal Aviation Administration (FAA), which has been slow to implement new air-traffic control technologies.

In many foreign countries, ‘privatization has not had an adverse effect on an air transportation system’s performance.’

Economists are once again wading into the deregulation debate, much to the chagrin of industry insiders but to the benefit of the traveling public. In Aviation Infrastructure Performance: A Study in Comparative Political Economy (Brookings Institution Press, $24.95), edited by economists Clifford Winston and Ginés de Rus, several authors explore how other countries have succeeded in enhancing their aviation infrastructure sectors through privatization.

When it comes to such privatization, the United States trails far behind the rest of the world. Indeed, its first large-scale experiment with private airport ownership began just a few months ago, when, as part of a pilot program run by the FAA, Chicago’s Midway Airport was sold for $2.5 billion to a consortium including Citigroup, Vancouver International Airport, and John Hancock Life Insurance. Winston and de Rus report that in many foreign countries, “privatization has not had an adverse effect on an air transportation system’s performance.” The countries that have experimented with airline privatization include Australia, New Zealand, the United Kingdom, Canada, and China.

In Australia, where airports are privately owned in order to optimize efficiency, airport operators “under pressure from regional interests” have incentives to make “excessive investments.” Early in the privatization process, price caps were set too low, causing airports to suffer excessive losses. The caps were then replaced by “monitoring,” which has allowed airport fees to rise but not above uncompetitive levels.

Canada’s major airports, by contrast, are owned by nonprofit corporations designed to boost airport investment. Their investment objectives have been largely achieved, but the nonprofit model has led to higher airport fees than might otherwise prevail.

China has adopted an incremental approach to privatization. Six of its largest airports have been listed publicly since the mid-1990s in order to improve airport efficiency. Although listed airports perform better than their unlisted peers, their performance has fallen short of expectations, which University of British Columbia scholars Anming Zhang and Andrew Yuen attribute to “the fact that the state (the local or national government) still maintains a controlling interest in all the listed airports. As a result of these partial privatizations, the state still has a great influence on their operation and investment decisions.”

The UK’s big experiment in aviation infrastructure privatization was a failure. Privatized in 1986, BAA plc (now owned by Spanish infrastructure giant Ferrovial) owns London’s three largest airports—Heathrow, Gatwick, and Stansted—which together comprise 91 percent of passenger traffic in the southeast of England. This past August, the UK Competition Commission reported that common ownership has had profoundly anticompetitive effects, and it recommended that BAA sell two of its London airports and one of its main Scottish airports. (BAA responded by beginning the process of selling Gatwick.) The original rationale for consolidating control of British airports was that only a large entity such as BAA had the resources to fund major improvements. But the Competition Commission found that BAA was capable of handling only one major project at a time, leaving its other airports—and London travelers—to languish.

The results of foreign privatization experiments affirm that competition, choice, and proper incentives are the essential components of a safe and efficient aviation infrastructure sector. U.S. policymakers and airline executives ought to pay close attention.

Evan Sparks, an associate editor at the American Enterprise Institute, blogs on aviation policy at EvanSparks.com.

                          ************

Would you buy a bridge from this man?

Macquarie Bank has made infrastructure funds a smoking-hot investment class. But the way it finances its deals has short-sellers circling, writes Fortune's Bethany McLean.

By Bethany McLean   Oct. 2, 2007

(Fortune Magazine) -- "This is the greatest single financial coup in the history of Chicago." That's how alderman Edward Burke, chairman of the city council's finance committee, described the 99-year lease of the Chicago Skyway, a 7.8-mile toll road, to a private operator for the stunning sum of $1.8 billion - almost $1 billion more than the next-highest bid. The deal, struck in late 2004, was the first privatization of a toll road in the U.S.

The Skyway runs from the skyscrapers downtown to the old steel mills of northwestern Indiana, where it meets the Indiana Toll Road, a 157-mile highway. Before long, Indiana Governor Mitch Daniels announced that he'd leased that road to the same private operator for $3.8 billion.  

Unusual as the deals may sound, the real surprise is that it took so long for them to happen. All around the world governments have been selling off infrastructure like toll roads, not necessarily because they want to but because they don't have a choice: They need the money.

The same is true here - the U.S. needs $1.6 trillion in infrastructure investment over the next five years, according to a report by the Urban Land Institute and Ernst & Young - but perhaps because we've been reluctant to face up to that fact, the bankers and consultants who do deals like the lease of the Skyway refer to the U.S. as an "emerging market."

If anyone thought that the investment wasn't a matter of urgency, the collapse of Minnesota's Interstate 35W bridge this summer, which took 13 lives, showed otherwise.

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Another surprise about these deals is that they weren't done by the usual suspects, like big Wall Street banks. Both the Skyway and the Indiana Toll Road were leased by two foreign companies working in partnership - a Spanish company called Cintra and a rapidly growing, highly controversial Australian firm called Macquarie Bank.

Macquarie, via funds that it controls, now owns chunks of 108 infrastructure assets around the globe, from parking lots in Manhattan to airports in Sydney, Brussels, and Tanzania to the Thames Water Co. in London to the Changshu Xinghua port in China.

Each day some 1.7 million cars drive on Macquarie's toll roads, some 115 million people pass through its airports, and some 60,000 people report to work at its assets. That, of course, makes Macquarie into something very different from just another financial services firm.

"These are major assets that affect people's lives," says Adam Nicolopoulos, a former UBS banker turned consultant.

Macquarie has its roots in Australia, where a serendipitous convergence took place in the mid-1990s. That's when a law was passed requiring Australians to put a percentage of their salaries into investments for retirement. At the same time, the cash-strapped government had begun turning over things like toll roads to private companies.

It was Macquarie that had the brilliant idea to put the two together by buying the right to run a toll road from the government and then selling that road to the public in an IPO. The theory was that a toll road - unlike, say, a technology stock - is a handy way to save for retirement because it produces a steady stream of cash that is relatively unaffected by economic downturns (are you going to stop using the roads?) or by competition (what other road are you going to use?).

Today "infrastructure funds" specializing in everything from toll roads to broadcast towers are as common in Australia as mutual funds are in the U.S.

The "Macquarie model," as both believers and skeptics call it, is now spreading around the world. Macquarie has funds listed everywhere from the New York Stock Exchange to the Singapore exchange. In total, the firm now manages A$225 billion, roughly half of which is devoted specifically to infrastructure; in the past 17 months, a fresh A$34 billion poured into its coffers, almost 80% of which came from outside Australia.

"It's just a huge market," says Macquarie CEO Allan Moss. "I think we've just scratched the surface of what we can do." Analyst Brian Johnson at J.P. Morgan is even less reserved. "How big is the opportunity?" he asks. He pauses, and then screams, "Massive!"

Risk returns with a vengeance

If the general public doesn't know the name "Macquarie" yet, Wall Street certainly does. Some 20% of its stock is owned by North American investors, including mutual fund giant Fidelity. U.S. pension funds such as the Illinois State Board of Investments are handing Macquarie money to manage.

And powerful firms from AIG (Charts, Fortune 500) to Goldman Sachs (Charts, Fortune 500) are following in its footsteps by raising multibillion-dollar infrastructure funds of their own. "MacWho?" was the question during the Skyway deal, says Dana Levenson, the former CFO of the city of Chicago, who is now leading an infrastructure group at the Royal Bank of Scotland. "Now these guys are everywhere, and everyone is taking notice."

Macquarie says it offers a straightforward service ("It's bloody simple," says Murray Bleach, head of the firm's North American investment-banking business).

In leasing the Skyway, Chicago got $1.8 billion in cash right away instead of by collecting tolls for 99 years. That enabled the city to pay down debt and put another $500 million into a rainy-day fund on which it collects interest - more interest than it was getting in annual tolls, says Levenson. It is now Macquarie and Cintra's responsibility to run the road, which encompasses everything from removing dead animals within eight hours to funding capital expenditures. (Within three months of taking over, it had installed electronic tolling.)

If, in 50 years, we all have individual flying machines and no one is using the road, it's a problem for Macquarie and Cintra, not for Chicago. And if the new operators fail to meet the city's roughly 300 pages of operating standards, the city can take the road back.

Of course, there's a price for all this. The toll went to $2.50 from $2 on the day that Macquarie and Cintra took over, and it will continue to increase.

Then again, it really isn't all that simple. There is widespread resentment and cynicism about the notion of private companies making money off what has long been perceived as public property.

Look no further than Indiana, where Governor Daniels's popularity ratings plunged in the wake of the sale of the toll road amid a hue and cry about foreign firms' owning our roads. And as the self-styled populist Lou Dobbs asked, "What right do they have to sell something that belongs to the taxpayer?"

But that's not the only reason Macquarie is controversial. No less a critic than Jim Chanos, the president of Kynikos Associates, who earned worldwide fame for being an early critic of Enron, is selling Macquarie's stock short. He argues that instead of inventing a new way to finance infrastructure, the firm is engaging in an old-fashioned Ponzi scheme.

So what does it mean if the financial structures underpinning Macquarie's assets are actually as unstable as the steel that supported the Interstate 35W bridge?

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On May 23, Chanos strode onto the stage of an elegant auditorium in Manhattan to address a highflying crowd. The event was the annual Ira Sohn conference, at which normally secretive hedge fund managers show off their top investment ideas. The ticket price of $3,000 goes to benefit children with cancer.

Chanos captured the audience's attention by opening with a quote from the Sydney Morning Herald: "The Macquarie model is justly famous around the world. It is quite possibly the most efficient method of legally relieving investors of their money ever conceived."

That Macquarie Bank is currently a highly profitable company is not a matter of dispute. Only a week before Chanos's talk, Macquarie had posted its results for its fiscal year ended in March 2007. The firm's profits were almost A$1.5 billion, up 60% from the year before and up from just A$250 million in 2002. (One Australian dollar is currently worth about 84 cents.)

The base management fees from its funds amounted to A$785 million. Through mid-July, Macquarie's stock, which was listed on the Australian Stock Exchange in 1996, had returned over 2,000%. At home Macquarie had become known as the "millionaires factory." In the past two years the top five Macquarie bankers earned A$216 million, with Moss and Nicholas Moore, the investment-banking head, making more than A$30 million each last year.

But Chanos is a contrarian, and on that sunny spring day he explained to the audience what he saw under Macquarie's glittering surface. The firm, he said, had a "perverse incentive to serially overpay for assets."

That's because the assets are owned not by the bank itself but by the shareholders in its funds. The shareholders pay Macquarie management fees that are based on the size of the fund, meaning that Macquarie has an incentive to add to its collection. (The funds also pay fees based on their performance, but as Macquarie gets bigger, those are dwarfed by the base fees.)

The shareholders pay Macquarie investment-banking fees too - any deal that a fund does, from the acquisition of an asset to a refinancing to its ultimate disposition - results in fees to Macquarie. In the past two years Macquarie Infrastructure Group (MIG) - the oldest and largest fund - has paid Macquarie a total of almost A$150 million in banking fees and another A$273 million in management fees.

That the funds are fee factories for Macquarie wouldn't be so much an issue - sure, it's more rapacious than your average private equity firm, but only a little - if it weren't for another part of the picture. That's debt.

Macquarie uses debt of as much as 85% to purchase an asset and pay for the necessary capital expenditures. This debt is hard to see, because it doesn't reside on Macquarie's books. You won't even see it by looking at the financial statements for the funds.

Instead, it is held at the asset level. For instance, if you glanced at the financial statements for MIG, you would see debt of A$2.6 billion. But the assets themselves carry another A$8.7 billion of net debt. In part because there is less disclosure on some of Macquarie's other funds, it is impossible to independently calculate how much debt there is across the entire empire.

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Over time the debt held by assets has often increased, not decreased, because Macquarie adds to it partly to pay shareholders their promised dividends. That's because the assets themselves don't deliver enough cash. Indeed, if you look at individual assets, from the Skyway to the M6, they may lose money after their interest expense.

So Macquarie borrows more money and uses it to pay the dividend now, much the way a homeowner might take out a home-equity line to pay a credit card bill. "Borrowing future growth to pay investors today bears the hallmarks of a Ponzi scheme," said Chanos.

There isn't anything illegal about what Macquarie is doing. But if the credit market shuts down, as the mortgage market did, and Macquarie can't pay the promised dividend, then the price per share of the fund would likely plunge - leaving the proverbial widows and orphans holding the bag.

If "Ponzi scheme" wasn't enough to grab the attention of the jaded hedge fund managers in attendance, something else certainly was: allegations of self-dealing. According to Chanos, 84% of the deals on which Macquarie was an advisor involved another Macquarie entity - which would imply that much of the parent company's ostensibly third-party advisory business was actually driven by the funds.

That isn't all. The same asset is often owned by multiple funds - for instance, Thames Water is owned by a consortium including no fewer than six Macquarie funds - and funds may own stakes in one another and sell one another assets.

For example, in 2006 a fund called Macquarie Infrastructure Partners (MIP) bought 50% of MIG's interest in four toll roads, including the Skyway and the ITR, for $825 million, resulting in roughly a $175 million profit to MIG (and A$5.8 million in fees to Macquarie Bank).

Chanos, of course, is a professional bear, and even last spring, before the convulsions in the credit markets, he was predicting an end to the salad days of ever cheaper debt. What would happen when times changed?

Already Macquarie was shifting its business model, which Chanos saw as a sign it was trying to avoid disclosure. Instead of creating publicly traded funds, Macquarie had begun raising funds that were more typical of a private equity firm. In the last fiscal year, 87% of the A$21.6 billion in fresh money that Macquarie raised went into unlisted funds, compared with 10% in 2003.

While Chanos may have been the first to say it and is one of the few who is willing to say it publicly, he's not alone in his skepticism about Macquarie Bank.

"This is a no-holds-barred bet on the credit markets," says another person who is short the stock. The skeptics don't merely argue that the firm's earnings will fall - which will happen to every financial services firm in a downturn - but that something more dire could happen.

It's not that they can lay out how events will unfold. Macquarie is too complex. Figuring out the firm is "like wrestling in the dark with a ghost," says another skeptic. It's just that from the outside, there's enough that seems flammable, from the funds to the parent company's 88% debt-to-capital ratio, to make people willing to bet that in a tough market, something, anything, will catch fire and set off a chain reaction.

You can see that in Macquarie's stock price, which plummeted 34% over the summer as credit markets tightened up, to a low of A$64 on Aug. 16.

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The furor was such that Macquarie, which does not usually open the gates to the press, decided to do just that. And so, about a month later, I arrived at Australia's Sydney Airport - which is owned by a Macquarie fund - during the early-morning rush hour, groggy after a long flight.

If you did the same thing, you might trudge through customs, not noticing much, perhaps, beyond the A$4 - gasp - it costs to hire a luggage trolley. But if you took the time to explore, you would realize that the airport is not a run-of-the-mill ripoff but an eerily efficient moneymaking enterprise.

You don't have to go far out of your way to buy souvenirs or coffee, because the airport's owners have studied how far you'll be willing to deviate from your path (five meters). You might buy a duty-free item not because you want one, but because doing so will shoot you into a special, speedy customs line. And should you drive to the airport, you would discover that parking your car in the shade ("the premium shaded parking product") costs an extra A$4.

Not that all this efficiency lessens the irritation that some users experience. As I shut the door of my cab, the driver begins an unsolicited rant about the fees he has to pay to wait at the airport. "Macquarie Bank owns it," he says. "They own too much."

To get to Macquarie's headquarters, you head up an escalator and into the old Sydney post office, which has been converted into a marble-floored atrium with a sky-high glass ceiling. A private elevator takes you to Macquarie's reception area, which features a stunning collection of Australian art.

If that's what you would expect, CEO Allan Moss is not. He is narrow and slightly stooped, with a fringe of whitish hair and spectacles. He is renowned for his clumsiness, and is a reserved conversationalist who will answer a question by flipping to a glossy presentation and augmenting it with an indecipherable scrawl.

He still delivers a ten-year anniversary speech for each and every employee, and is worshipped by many of them - and by some investors. "He's the smartest man I have ever met, and yet he's always willing to listen," says analyst Brian Johnson (who owns Macquarie stock). And you do get the uncomfortable sense that there is something quite calculating clicking away beneath his reserved surface.

About Chanos he says: "We think a lot differently about people who are genuine stakeholders vs. people who have a passing casual interest." He adds, "It's the same criticism that was being made in Australia five years ago. It is noise, but no more than noise."

Moss is referring to 2002, when Macquarie bought the Sydney Airport and smacked into a wall of public negativity about its entire business model. This was six years after Macquarie had taken its first toll road public, and its infrastructure funds, which touched the lives of ordinary Australians, from their roads to their retirements, had boomed.

Now the bank was buying the airport, extracting its fees, and putting the asset into a fund that would be owned by the public - and those ordinary Australians would pay the price if the bank had gotten it wrong. The A$5.6 billion that Macquarie had paid - some A$600 million more than the next bid - was criticized as dangerously high by radio host Alan Jones, who is to Sydney what Howard Stern is to New York. Macquarie's stock price plunged more than 50%.

Five years later it appears that Macquarie has proved its critics wrong. Profits at the airport have more than doubled, to A$527 million, and the investment is regarded as a huge success. "Macquarie has been told it's wrong but been proven to be right so often that it may begin to believe that it can make money out of any deal at any price," says a former employee.

Today Australians regard Macquarie Bank with a mixture of fascination, pride, intimidation, and resentment. In its home country the firm has the mystique of a Goldman Sachs combined with the omnipresence of a Google (Charts, Fortune 500). Macquarie is as entrepreneurial as any technology startup, the sort of place where, says investment-banking head Nicholas Moore, a young Aussie working in New York may decide to move to a Mumbai hotel room with his 2-month-old baby to jump-start Macquarie's business there. (That just happened.)

"We don't say, 'Here's a big guaranteed bonus,'" says Moore. "We say, 'Bye-bye. We'll support you, but it's yours.'" These days every smart young Australian who wants to work in finance wants to work at Macquarie Bank - and those who work there often think there's no place else worth working.

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Moss, an Australian, joined the firm in 1977, straight out of Harvard Business School, where he graduated as a Baker Scholar. Back then the firm was the small Australian subsidiary of a large British firm called Hill Samuel, operating out of a two-room office. Moss had intended to work on Wall Street - in fact, he and his wife, Irene, left their belongings in New York City when they headed back to Australia for a vacation.

Instead, Moss had a friend sell their stuff. "There was a real sense that we were building a business - that we had lots of ideas here," recalls Moss.

In 1985 the firm split off from Hill Samuel and renamed itself after Lachlan Macquarie, the governor of New South Wales from 1810 to 1821. The historical Macquarie is famous for an early feat of financial engineering in which he solved a currency shortage by punching out the middle of Spanish silver dollars, thereby creating two pieces: the holey dollar, and the dump.

The move doubled the number of coins and also increased their value by 25%. The holey dollar became the logo of the new Macquarie. But the pursuit of the dollar is supposed to be balanced by prudence - Moss created a risk-management division about the time the firm took its new name.

Every deal has to be approved by a group whose job it is to worry about how much money could be lost. Moss uses the phrase "freedom within boundaries" to describe this balance. (He used to call it "loose tight," but that phrase became associated with Enron's Jeffrey Skilling.)

Moss, who became CEO in 1993, insists that he never aspired to run Macquarie. The culture was "one of dealmaking," he says, and "what happened in management seemed secondary." Nevertheless, he has presided over the firm's expansion from a successful but small Australian boutique to a global force.

In bad markets Macquarie has snapped up business from struggling firms: It bought Banker's Trust's Australian business in 1999 and ING (Charts)'s Asian brokerage business in 2004. Macquarie has built its own retail brokerage business and has expanded from offering mortgages to financing developers to managing real estate funds globally.

Stephen Girdis, a 20-year Macquarie veteran who runs the real estate business, says that per employee, it is the most profitable area in the firm. Every part of the firm seems to grow at a double-digit clip. Says Andrew Downe, who runs treasuries and commodities, which encompasses everything from trading energy to financing gold mines: "We're up, like, a lot, and the percentage contribution has gone down. That really takes the gloss off of it."

Even so, if it weren't for the infrastructure funds, Macquarie probably wouldn't be known outside Australia. The infrastructure funds are part of Moore's investment-banking group, which contributes 58% of the firms' profits.

When people use the word "aggressive" to describe Macquarie - which everyone does - they're talking about Moore's IBG. Moore was trained as an accountant and joined Macquarie in 1986 to advise corporate clients on taxes. Clearly he's analytical, but he is also able to control hundreds of ambitious, hungry dealmakers by sheer force of personality.

"He's the guy you want in your corner in a boardroom or in a dark alley," says one observer. He is charming and chatty, with steel-gray hair and an easy smile, but that doesn't mask his relentlessness. "We put the grunt into the space," he says. "Are we the smartest guys? Who knows?" He adds, "But we will go in with a lot of guys."

Moore is a financial services street fighter, and he's one who says he believes in that world's umpire. "The market is always right there," he says.

Bear Stearns' wrong turn

The funds, though, are also the reason that Australians ask some of the same questions Chanos did. Indeed, while the suspicion at the time of the Sydney Airport deal was submerged by Macquarie's success, it didn't go away.

Last year a rival bidder for a ports company in Australia ran ads accusing Macquarie of paying a "heads they win, tails you lose" game with investors in its funds because of the fees that it extracts. Philip Wensley, an analyst who covers MIG for Morgan Stanley, wrote in a note to clients that the actual cash flow covers roughly one-third of the promised dividend to shareholders.

Last January, Merrill Lynch analyst Matthew Davison pointed out that none of five large publicly traded Macquarie funds can fully fund their distributions. That's part of why Davison labeled Macquarie "the house that debt built." He also cited the "aggressive structuring" of the debt at the asset level. (See correction.)

For instance, on both the Indiana Toll Road and the Chicago Skyway, interest payments are very low in the early years, which increases cash flow at first but leads to much higher interest in out years - akin to a mortgage with a low teaser rate. In 2007 the Skyway will pay interest of just $129,000 on $961 million of debt. But the interest payment for 2018 is to be $480 million - that's not a typo.

There are other signs that what's best for Macquarie executives isn't necessarily best for its constituents. While Australians have long resented the pay at Macquarie, last June a stunning 21.4% of shareholders voted against the firm's pay packages after proxy-advisory firm Institutional Shareholder Services recommended that they do so.

ISS's main complaint is that while a small part of executive pay is in stock, most of it - 74% last year - is cash. "Executives could potentially receive the vast majority of their bonus for delivering unsustainable and potentially risky gains in profits in a single year," ISS wrote. (Macquarie issued a 15-page rebuttal in which it said, among other things, that its executives had their money locked up in the firm for long periods.)

Macquarie's broader defense of its business is simple. Infrastructure is "a new asset class," says Stephen Allen, CEO of the Macquarie Infrastructure Group. "I've gone through the process with people where we've explained the business, and many of them had the same questions you've had."

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Specifically, Allen says that interest on the debt an asset may carry is sculpted to match the cash flows it will produce. Take a toll road, which may require heavy upfront capital expenditures - some $700 million in the case of the ITR.

Initially the road may produce little free cash. But as spending shrinks and the tolls rise, the cash falls straight to the bottom line. In the final years of the lease, the cash-rich asset pays off debt. Therefore, Allen argues, it makes sense to have the interest payments increase in later years. This is also the reason that he says it makes sense to fund distributions to shareholders out of debt in the early years.

Allen says that the ability to raise more money by refinancing debt is driven not by the capital markets but rather by the credit quality of the asset, which improves with time as risk diminishes.

Macquarie also defends the performance of the funds, pointing out that while they have lagged recently, over their life they have returned an enviable average of 19.8% annually. In addition, the funds have sold nine assets - most recently a stake in the Rome airport - to third parties for more than $8 billion, or 2.3 times the original equity invested in them.

Moore says that the firm is creating unlisted funds simply because the demand is now from institutional investors like pension funds, which are used to private-equity-type deals. And Macquarie, which stresses the diversity of its businesses, denies that its banking fees are dependent on the funds.

In the fiscal year ended in 2007, Macquarie says that advisory, M&A, and underwriting fees paid by its infrastructure and real estate funds amounted to only A$250 million, or roughly 20% of such fees. This figure, though, is narrowly defined. For instance, when Macquarie leads a consortium of investors, as it did in the acquisition of Thames Water, the fees paid to Macquarie by the outside investors, as well as the fees paid by Macquarie funds that are not part of the infrastructure or real estate groups, are excluded from the A$250 million.

As for the bank itself, Macquarie risk-management head Nick Minogue says that the firm constantly runs models showing what would happen in a severe three-year downturn. "I won't tell you the numbers," Minogue says. "People would be horrified if you print them. They aren't pretty. But we would come out a well-capitalized bank."

The conventional wisdom is that even if the funds do run into trouble, Macquarie Bank will be able to finesse any problems that ensue. Steve Johnson, a former Macquarie banker who now works for Australia's Intelligent Investor, is skeptical about the funds. But he is a believer in Macquarie itself, which he likens to a cigarette company: "They make an unsavory product, but as long as people buy it, they make money."

Subprime: Let the finger-pointing begin!

When you ask Allan Moss what his biggest worry is, he says this: "The big difference between the 1980s and the period we're in now is that it is far more important to us that we be conscious of our community responsibility." Given the importance of our roads, airports, and water utilities, it would take only one disaster to end the privatization party.

That's especially so right now in the U.S., where resistance to privatization has become something of a cause célèbre. Take the fiscally wobbly state of New Jersey, which under the leadership of former Goldman Sachs CEO Jon Corzine was planning to privatize its turnpike.

On June 28, after months of controversy, Corzine released a statement that began, "New Jersey's roadways will not be sold, and they will not be leased to a for-profit or foreign operator." (That is somewhat ironic, given that New Jersey's pension plan owns some $71 million worth of MIG.)

Texas granted Cintra a concession to develop a new toll road, but after protests, it was yanked and handed to a state agency. Truck drivers have banded with the American Automobile Association and others to create a coalition that opposes the privatization of toll roads.

"American consumers will pay twice: once when they drive on the roads, and again in the increased cost of the goods they consume," says Clayton Boyce, the vice president of public affairs at the American Trucking Association. He also points out that the federal Interstate Highway System was designed to be a system. What happens if it is broken up into chunks owned by different parties?

Even some believers in privatization say it isn't a panacea. "These decisions need to be scrutinized, interrogated, challenged, to ensure that the model is sustainable over the long term," says consultant Nicolopoulos, who has been advising on infrastructure deals for 20 years.

Unlike other countries, the U.S. has a robust municipal bond market, meaning that there are other ways to raise money. And yet the simple truth is we need so much money that saying a flat no to any source of funds borders on the insane.

Despite the controversy, the landscape is already being reshaped. By early 2008, Rob Collins, head of infrastructure M&A at Morgan Stanley, says there could be deals for Chicago's Midway Airport - despite protests from the airlines that use it - the Indiana lottery (Marx would have a field day), the Pennsylvania Turnpike, and the Port of Portland.

"To ignore the willingness of the global capital markets to fund infrastructure would be a tragic mistake," says Tom Osborne, the co-head of infrastructure in the Americas for UBS.

Collins estimates that there is now some $700 billion (including leverage) available for infrastructure investment. But because of the pushback, that gigantic pool of impatient capital is searching for deals that aren't materializing as quickly as they were supposed to.

"Guys are paying big multiples just to get a flagship asset in their funds," says one banker. "There is a shortage of assets." Partly as a result, argues Mike Wilkins, a credit analyst at Standard & Poor's, buyers are relaxing their definition of what infrastructure is and paying high multiples.

In a report he warned, "It is clear that as a result of rampant demand, the infrastructure sector is in danger of suffering from the dual curse of overvaluation and excessive leverage - the classic symptoms of a bubble."

Lately Macquarie has missed out on several high-profile deals, including the lease of four Mexican toll roads, which it lost to Goldman Sachs. Both Moss and Moore say, though, that nothing has changed, because their business has always been competitive. "It's not like we're putting all our bets on No. 26. We've got a lot of bets out there all the time," says Moore.

It's nice to imagine that a toll paid electronically on a Chicago highway could help fund the retirement of someone halfway around the world. But even if the Macquarie model doesn't work, the firm will have made a difference: Our infrastructure is now in play.

Reporter associates Doris Burke and Patricia Neering contributed to this article.

Correction: Matthew Davison is with Morgan Stanley, not (as we reported) Merrill Lynch

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Road Users, Hill Leaders to Fight Leasing

WASHINGTON - A coalition of highway user groups opposed to the sale or long-term lease of U.S. infrastructure to private entities picked up the support of three powerful congressional chairmen, even as supporters of such deals continued to tout privatization as a solution to transportation funding shortfalls.

The coalition, launched at a Feb. 9 press conference here, aims to "combat the growing trend toward privatization or the leasing of existing toll facilities to private investors," said Bill Graves, president of American Trucking Associations.

Other coalition members are: the American Highway Users Alliance; AAA, formerly the American Automobile Association; NATSO, previously known as the National Association of Truck Stop Operators; the Owner-Operator Independent Drivers Association; and the Recreational Vehicle Industry Association.

Meanwhile, Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee, said privatization "does not serve our nation's highway needs," because "it's very difficult to have a national system" of highways with a series of private roads.

Calling privatization "a siren song," Baucus told ATAs leaders at the federation's winter executive meeting Feb. 13 that he supports their "drive against privatization." Also last week, Reps. James Oberstar (D-Minn.) and Peter DeFazio (D-Ore.), chairmen of the House Transportation and Infrastructure Committee and that panel's highways subcommittee, respectively, expressed serious concerns about privatization in a Feb. 13 hearing (see story, p. 3).

The new coalition, named Americans for a Strong National Highway Network, would "hold government accountable for ensuring that financing is transparent, motivated by the public good and dedicated to transportation," Graves said.

"Selling or leasing existing highways to private interests is inconsistent with those three principles," Craves said.

Todd Spencer, executive vice president of OOIDA, said that while "selling our highways may be good for the investor community and Wall Street," it is "simply bad highway policy."

Spencer said states' rush to tollroad privatization was a "pawn-shop mentality, the payday loan mentality, and we can do a whole lot better than that."

The U.S. Department of Transportation has been promoting the concept of privatization and public-private partnerships in recent months. DOT officials met with state transportation leaders Feb. 9, including the governors of Indiana and Pennsylvania - two states involved in the move toward privatization.

"It is an idea whose time has come," Transportation secretary Mary Peters said Feb. 13 at the U.S. Chamber of Commerce.

Privatization is "one of the most promising options" available to improve transportation because it brings "much-needed capital into our transportation network," she said.

After the DOT meeting, Indiana Gov. Mitch Daniels (R) said it was "a very practical conversation." Indiana recently leased its toll road for $3.8 billion and Daniels has been a vocal advocate of privatization.

Daniels called on Congress not to prevent future deals. "Congress can be a force against progress any time it wants to, I suppose," he said. "Congressman DeFazio is a left-wing extremist on this, I'm sorry to say."

Pennsylvania Gov. Ed Rendell (D) told reporters the state was looking at leasing the Pennsylvania Turnpike "purely out of necessity," saying the state nas received estimates of between $8 billion and $30 billion for a turnpike lease.

Members of the anti-privatization group did say there could be a place for private capital in transportation finance, but Graves said, "It certainly should be an extremely limited role."

"I think that we agree that the nation's infrastructure needs are severely underfunded," he said. "Generating the necessary funds to support those needs, however, must not solely become a matter of selling off our nations or our states' assets."

"The only discussion" the federal government and many states seem to be interested in, Graves said, "is about how do we find opportunities for the investment to come in and solve whatever financial woes we have."

He said ATA supported the continued use of the fuel tax to fund road projects, and that it should be raised, provided taxpayers see value for their increased contribution.

Lisa Mullings, president of NATSO and a coalition member, said it was "a fundamental government responsibility to provide a transportation network and not something that should be delegated to private or foreign interests."

Jill Ingrassia, director of federal relations for AAA, said privatization was "not appropriate for all roads, not appropriate in all situations, and they certainly are not a magic bullet."

Coalition members complained about the process of privatization, contending they have been "shut out" of "meetings at the highest levels of government" on the subject," said Greg Cohen, president of the American Highway Users Alliance.

DOT spokesman Brian Turmail said Peters "has met with many of the groups involved in [the Feb. 9] announcement, including addressing the ATAs board of directors late last year, and is always eager to hear comments and suggestions."

Editorial Director Howard S. Abramson contributed to this report.

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Virginians Pay Australian Toll CEO Salary

Virginia motorists paid $13.7 million in tolls to an Australian company that paid its former CEO $14.3 million.

It took more than a year's worth of toll revenue on a Virginia highway just to pay a single employee of an Australian firm. Last year, Virginia motorists handed the Melbourne-based company that operates the Pocahontas Parkway near Richmond a total of $13.7 million in tolls and fees. The amount reflected a significant increase over the previous year as Transurban raised toll rates steeply in January, but it failed to cover the salary of CEO Kim Edwards who pocketed $9.2 million in bonuses and $5.2 million in termination benefits for his departure from the company in April. Combined with his salary, his total payout was A$16,664,532 (US $14,316,553).

Now that Edwards is gone, Virginia tolls do not even cover the multi-million dollar compensation packages offered to Transurban's top six executives. New CEO Chris Lynch takes the largest share with $3,839,783 in compensation. The other seven-figure employees take home the following in pay and other benefits:

• North America President Michael Kulper, $3,056,337
• Chief Financial Officer Chris Brant, $2,289,561
• Chief Operating Officer Brendan Bourke, $2,245,434
• Executive Vice President Ken Daley, $1,917,822
• Group General Manager P O'Shea, $1,764,101
• Total Compensation for key management: $34,651,427

The massive payments were made despite the company's net operating loss of more than $140 million. Transurban is not alone in imposing massive overhead costs on motorists for the operation of toll roads. Our analysis shows that even the best managed toll roads in the US are twenty-five times less efficient in collecting revenue than state gas tax collection (view report).

thenewspaper.com

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Virginia Toll Road Company Made Illegal Donations
Illegal campaign donations by Transurban helped secure 80-year tolling deal in Virginia.

An Australian toll road company is on the hot seat for funneling $177,000 in illegal campaign cash to Virginia lawmakers since 2005. The Washington Post reported earlier today that the Federal Election Commission (FEC) is investigating the issue and that Transurban has already asked state legislators to send back any campaign checks that may have violated the law.

According to the federal regulations governing elections, "a foreign national shall not, directly or indirectly, make a contribution or a donation of money or other thing of value... in connection with any federal, state, or local election." (11 CFR 110.20).

Transurban, which is headquartered in Melbourne, made the donations to help secure the rights to toll portions of the Capital Beltway and Interstate 95. In return for contributing just $349 million of their own capital to the Beltway expansion project, Transurban earned the lucrative rights to bill Virgina drivers for at least eighty years. The rest of the project was financed with $1.6 billion in federal and state grants, loans and guarantees (details).

Many of this deal's biggest supporters were recipients of significant contributions from Transurban. Governor Tim Kaine (D) got $19,500 for his inaugural, leadership and campaign warchest. House Speaker William J. Howell (R) took $12,500 for his leadership committee. Delegate Dave Albo (R-Springfield) received just $500.

The contributions fell afoul of federal law because the FEC's definition of a foreign national includes foreign corporations. Most lawmakers were unaware of this because media reports often incorrectly refer to companies like Transurban as "Transurban USA" in the same way that red light camera vendor Redflex is called "Arizona based," suggesting they are not wholly owned and controlled by foreign corporations. Both Transurban and Redflex, for example, are listed on the Australian Stock Exchange. Each company ultimately answers to a CEO and board comprised of foreign nationals. When money flows from the foreign parent company to the US office, it becomes impossible to tell whether the foreign nationals are directly bankrolling the political donations, which is the most clear violation of federal statute in question.

US election law also makes it illegal for state lawmakers to receive such contributions knowingly. Although it is unlikely to applied in this case, FEC rules state that legislators would be liable if they were, "aware of facts that would lead a reasonable person to inquire whether the source of the funds... received is a foreign national, but the person failed to conduct a reasonable inquiry."

These lawmakers, however, will not need to return other sources of campaign cash used to secure their support for the Beltway HOT lanes. Fluor Enterprises, a ten-percent partner in the deal, gave Virginia lawmakers $242,685 in donations since 2001. Fluor is based in Dallas, Texas. Transurban has also retained the lobbying services of seven influential lobbyists who are free to make donations of their own. Lobbyist H. Benson Dendy, III, for example, has given candidates $14,932 over the years, according to the Virginia Public Access Project.

Transurban told the Post that the returned donations would be donated to charity

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